Montreal, Canada
Since May 1st, the S&P 500 Index has declined 8.2% compared to a loss of 12.7% for the Russell 2000 Index of smaller companies. And in the latest correction since the May "flash crash," small stocks have entered bear market territory, defined as a loss greater than 20% from their highs.
Increasingly, investors are moving away from riskier smaller stocks and heading into the relative safety of large-caps – many paying dividends about 50% to 100% greater than the yield on the broader market. This transition is justified since the U.S. economy is in the process of slowing while overseas markets – mainly in Asia and Latin America – are growing strongly.
Small companies rely on domestic sales much more than large-cap companies. Though the former has definitely outpaced larger stocks historically, that edge has been on the decline over the last three months as investors grow nervous and hunker down to the relative safety of big companies paying above-average dividends.
Last month I made the long-term case for owning several large-cap U.S. multinationals with an emphasis on overseas earnings. One of my favorites is Coca-Cola (NYSE-KO), trading at the same price this morning compared to twelve years ago. Coke also yields 3.4% -- or 55% more than the S&P 500 Index. Coke continues to generate most of its net margins from overseas sales, not domestic sales. That's a trend that's likely to persist for many years to come as the emerging markets become significant consumers.
Going forward, it seems, the United States will struggle as domestic consumption lags amid an environment of debt reduction and balance sheet repair; that's not the case in the emerging markets. These countries, which already experienced the tribulations of a wicked bear market in 1997-1998, are home to the world's biggest trade surpluses, foreign exchange reserves and debt-to-GDP ratios of just 40% compared to more than 80% or more in many developed economies. Multinationals are aware of this development and it's no surprise everyone is running to China and other emerging markets to land big sales.
The majority of emerging markets are fairly valued at best and at worst, not cheap. The MSCI Emerging Markets Index used to trade at a fraction compared to the MSCI World Index of major markets but that ratio has compressed significantly since 2003. Instead, I prefer to hunt after multinationals that derive the bulk of their profits from these economies, accompanied by lower multiples and attractive dividends. Coke is one example. Stocks like Coke offer a greater margin of safety than many "bubble" emerging market stocks, which pay little or no dividends.
Comments